I – THE CORRELATION OF CYCLES IS ONE OF THE CHARACTERISTICS OF THE “OPTIMALITY” OF OUR

CURRENCY AREA, BUT IT IS AN ACHIEVEMENT THAT MUST BE MAINTAINED

Three essential foundations for characterising currency areas were highlighted in studies by Mundell and MacKinnon in the early 1960s: the integration of financial, product and services and labour markets.

The integration of the product market is currently the most apparent foundation of the robustness of our monetary union. A high degree of trade interdependence links euro area countries to each other. For example, half of the external trade of France and Germany consists of intra-euro area flows²⁴; as a weighted average for the euro area this proportion stands at 50%²⁵.

Around two-thirds of the imports and exports of Central and Eastern European countries (CEECs) are carried out with the euro area. Forty percent of this is intra-industry trade, compared with 50% for intra-euro area intra-industry trade. These data undeniably confirm the dynamic integration process.

Trade interdependence in the euro area has developed between relatively diversified economies, and in particular in the form of intra-sectoral trade.

Consequently, over the past forty years, a tendency towards the specialisation of sites has emerged within each economy, leaving economies with a fairly large degree of sectoral diversification.

We do not have sufficient hindsight to determine the extent to which this model of interdependence via intra-sectoral trade will continue to prevail, or whether increased sectoral specialisation will develop. I tend to believe that the second hypothesis is the most likely. This issue must be borne in mind in all forward-looking studies on the conditions for enhancing the “optimality”

of the euro area, and I will come back to this point in my third series of comments.

242002 data for France: exports + imports as a % of GDP = 26.3%, of which extra-euro area = 13.2%. Same year for Germany: 34% and 19.6% respectively. Figures from the two previous years are of a similar order of magnitude.

25Average over the period January 2002 – August 2003.

In the current environment, the correlation coefficients of the business cycle are high for industry – over 0.8 for France and Germany for example – and the correlation is “contemporaneous”. The European services cycle is however less marked and more fragmented between countries. For Central and Eastern European Countries, the coefficient is 0.45 on average for the industrial output index, with a broad dispersion of individual situations.

However, trade interdependence is not in itself sufficient to guard a Monetary Union against the asymmetric shocks affecting the area’s different economies. The correlation of cycles also closely depends on the degree of convergence of economic structures and national economic policies.

This degree of convergence may be assessed to a certain extent by taking into account rates of inflation. I wish to stress that euro area monetary policy has a euro-area-wide price stability objective and does not act directly on national inflation differentials. Yet, these inflation differentials may reflect, on the one hand, the degree of homogeneity of economic structures and, on the other, an ability to absorb asymmetric shocks within the area. They therefore constitute a useful indicator. At present, the average annual standard deviation of inflation (measured by the Harmonised Index of Consumer Prices) between euro area Member States is comparable to that prevailing between the 14 main metropolitan statistical areas of the United States. This is a remarkable result considering that monetary union came into force in 1913²⁶ in the United States. Admittedly, inflation differentials between euro area countries are not negligible, but this is not specific to our currency area.

The homogeneity of the euro area also relies on the similarity of financial structures between countries and the integration of financial markets

The relative homogeneity of financial structures – illustrated for example in the “Report on financial structures” published by the European Central Bank in 2002 – shows that the transmission channels of monetary policy are also fairly comparable, with the interest rate channel playing the prominent role in all countries and the bank credit channel a less predominant role ²⁷.

26Actually the Federal Reserve Act of 1913 sets the framework for a single monetary policy.

However the founding principle of a monetary union dates back to the Constitution that included a clause forbidding States to coin money and emit Bills of Credit after 1787.

27These were the findings of a series of studies coordinated by the Eurosystem Monetary Transmission Network, and published in the ECB Working Paper Series No. 91–114.

As regards financial markets, since the introduction of the euro, reforms for completing the integration of infrastructures (trading platforms, delivery-versus-payment systems, central securities depositories), and procedures and standards have been gathering momentum. The “Lamfalussy method”, in application as of 2001, has now been enhanced by the rapid implementation of the European Commission’s Financial Services Action Plan.

In addition to an already highly integrated money market, whose turnover and homogeneity are comparable to those of the US market, – even though the volumes traded within the individual segments are not entirely analogous on these two major markets –, the rapid integration of markets will no doubt foster increased depth and liquidity, which will naturally strengthen the euro area’s capacity to absorb asymmetric shocks: these shocks can be spread over a greater number of counterparties, with a much better exploitation of arbitrage opportunities, in particular intertemporal trades.

HOWEVER, THE DEGREE OF LABOUR MARKET INTEGRATION IS LOW AND LABOUR LAW IS A SOURCE OF RIGIDITY AND HETEROGENEITY Measuring the integration of the labour market is not an easy task, given the large number of variables to be taken into account. I will cite three considerations:

– first, the dispersion of unemployment rates: different composite dispersion indicators show that there is a higher degree of dispersion in the euro area than in the United States, but the differential is not however very significant²⁸. Furthermore, in the United States there is a complex and dynamic economy and, at times, some states may be booming while others are in the process of redevelopment, which temporarily generates substantial unemployment differentials;

– second, differences in labour market structures. For example, according to various estimates by the European Commission, the relative weight of public sector employment is twice as great in some countries as in others:

for example, 14% in the Netherlands, 17% in Germany, and over 30% in

28 Calculations for the 11 countries (excluding Luxembourg) in the euro area and the 52 American states, over the period January 1993-July 2003: average of the standard deviation to average unemployment rate ratios: 0.18 in the United States and 0.20 in the euro area. Min-max difference ratio: 0.4 in the United States, 0.6 in the euro area (and 0.52 excluding Ireland). Taking different reference periods, the dispersion is sometimes lower in the euro area than in the United States, in particular at the period-end. Among other conclusions, it can be deduced from these results that geographical mobility is not yet so developed in the United States as to level out, in the short term, unemployment rate differentials between regions.

France and the Scandinavian countries. According to another indicator, the relative weight of the “informal sector” appears to vary between around 5% in countries where the informal sector is the least developed and 20%

in those where it is traditionally the most extensive²⁹;

– third, institutional obstacles. These include the highly incomplete mutual recognition of diplomas and qualifications, differences between unemployment insurance regimes, and the lack of transferability of rights acquired in national health and pension systems.

– Moreover, the complexity of labour laws in many countries³⁰ suggests that rapid progress in this area could only be achieved through strong political will.

It is this same political will that lent credibility, during the 1990s, to the objective of European Monetary Union. Without doubt, as regards European unification, major labour market reforms are still necessary, and an association such as SUERF could contribute greatly to enhancing and disseminating the economic arguments underlying the importance of this issue.

In sum, the euro area’s solidity stems from:

– an already highly integrated product and services market;

– integrating financial markets;

– relatively homogeneous structures – excluding labour markets;

– the combination of these three aspects, which are reflected in the correlation of the business cycle.

The euro area is however still young and its capacity to absorb asymmetric shocks has not yet been fully put to the test. Moreover, the euro area, just like any other currency area, is a permanently evolving entity and vigilance is required with regard to its position in terms of optimal currency area criteria.

This leads me to two other series of comments:

– In order to become resilient to such shocks the euro area must adhere to the principles of sound fiscal management ensuring that national budgets have enough flexibility to withstand asymmetric shocks;

– So as to preserve and enhance the optimality of the area regardless of medium-term endogenous developments, appropriate structural policies, in particular concerning the labour market, must be initiated.

29According to a compilation of estimates by the European Commission – 1997

30See OECD “labour market regulation indicator”: in 2002 the five major euro area countries are ranked between 13^th(Netherlands) and 22^nd(Spain), the United States and the United Kingdom are in first and second place respectively. (According to this indicator, countries with the least restrictive labour laws rank highest).

II – FISCAL POLICY MUST PERFECTLY FULFIL ITS FUNCTION